Question

For this assignment you will need to view the economy as a whole (aggregate) and not from your own industry. Assuming our economy is experiencing unemployment of 7.5% and people are generally feeling good about the economy. According to Keynesian theory, what could happen in our economy to create a recessionary gap? The second part of the assignment is to explain one thing our government could do to recover or correct that recessionary gap?

Answer 1

Recessionary gap exhibits a negative output gap, where the current output is less than the full employment level of output. Recessionary gap can be result of a demand shock or a supply shock. We are given that people are generally feeling good about the economy so there should not be a demand shock from consumption pessimism or investment pessimism. Keynesian theory suggest that a business contraction generally leads to recessionary gap where current output is less than full employment level and unemployment is greater than its natural rate. InIthat case there will be a recessionary gap. Government can use its fiscal policy to stimulate the spending. An expansionary fiscal policy of increasing government expenditure or reducing taxes will be helpful in shifting the aggregate expenditure curve to the right and ensuring that the communities is full employment level of output.